Is the Great Resignation a Figment of Our Imaginations?

Summary

• US labour participation is an outlier: it has fallen by more and recovered by much less than in other advanced economies.
• This reflects higher US unemployment, a worse pandemic and insufficient childcare and parental leave.
• Participation could take several years to recover, but history shows this need not be inflationary.

Market Implications

• A slower-than-expected participation recovery will likely see the Fed hike more aggressively than the market currently expects.

US Exceptionalism: Low Participation, High Unemployment

The absent recovery in US labour participation has many discussing ‘the Great Resignation’. This is a reassessment of the work-life balance away from work, which would reduce US labour supply, hinder sustainable growth, and add to inflationary pressures. But I argue for another explanation of the anaemic participation: the policy response to the crisis and structural features of the US labour market.

Flat and low participation is a uniquely American development (Chart 1). Participation is still 2.5% below pre-pandemic levels in the US but has recovered to within 1% in most advanced economies. In Australia, participation recovered to above pre-pandemic levels by Q4 2020 but recently fell due to increased Covid infections and stay-at-home orders. With infections falling, the RBA expects a fast recovery in participation as many laid-off workers who have not been job seeking expect to return to their old jobs.

Workers’ attachment to the workforce is a key driver of participation, and attachment tends to be broken by unemployment. Unemployed workers are much more likely to drop out of the workforce than employed workers. Consequently, participation falls when unemployment rises and typically recovers with a lag, as a paper at this year’s Jackson Hole explained. In 2020, the US had the largest unemployment increase of advanced economies. Higher US unemployment in turn largely reflects the policy response to the pandemic where subsidies to businesses were more loosely tied to employment than elsewhere.

Compared to previous recessions, current participation is appropriate for the labour market slack. Current participation rates align with those observed at similar levels of unemployment after the GFC and tech bubble. They are, however, lower than those during the recoveries of the 1970s, 1980s and 1990s, but this seems to reflect a structural change rather than the current situation.

That said, high unemployment cannot be the whole story behind the weak US participation. Since Q4 2020, Canadian unemployment has had a nearly identical trajectory to that of the US . Yet Canadian participation is 0.5ppt below pre-pandemic levels, while US participation is 2.5ppt.

US Structural Weaknesses to Keep Delaying the Participation Recovery

In addition to high unemployment, several longer-term factors explain the absent recovery in US participation. First, Covid remains more prevalent in the US than in many advanced economies.  This likely reflects the low immunity of the US population. And it is hampering participation through negative perceptions of workplace safety, lack of childcare services, and the inability of businesses to offer stable hours and pay.

Second is the lack of parental leave and the weak childcare system in the US. Both are often cited as drivers of the low participation, especially that of US women compared with, for example, Canadian women.

The third factor of the absent participation recovery is successive cash payments to US households. These created a savings buffer that is probably facilitating a delayed return to the workforce. In September, the household savings rate was back to its pre-pandemic level. Strong October retail sales suggest the savings rate has fallen further.

Participation Could Be Flat for a Few Years, but Need not Be Inflationary

US participation took six years to start increasing after the 2009 unemployment peak. And the recovery in participation did not happen until real wages started rising. This time, real wages have been falling and may need to recover for participation to start increasing. This could take several years.

Low participation need not be inflationary, however. Participation fell from the late 1990s to the mid-2010s, yet inflation mostly underperformed due to factors such as demographics, rising income inequality, weak worker bargaining power and globalization. These long-term disinflationary trends have changed little. Consequently, as the pandemic recedes and participation remains flat, I expect inflation to revert to pre-pandemic trends.

Market Consequences

The FOMC hawks view of participation is much less sanguine than mine which suggests the Fed could tighten too early and too much next year.